Points, also called a "discount point", are a form of pre-paid interest. One
point equals one percent of the loan amount. By charging a borrower points, a
lender effectively increases the yield on the loan above the amount of the
stated interest rate. Borrowers can offer to pay a lender points as a method to
reduce the interest rate on the loan, thus obtaining a lower monthly payment in
exchange for this up-front payment. For each point purchased, the loan rate is
typically reduced by 1/8% (.125%).
Paying Points represent a calculated gamble on the part of the buyer. There
will be a specific point in the timeline of the loan where the money spent to
buy down the interest rate will be equal to the money saved by making reduced
loan payments resulting from the lower interest rate on the loan.
Selling the property or refinancing prior to this break-even point will
result in a net financial loss for the buyer, while keeping the loan for longer
than this break-even point will result in a net financial savings for the buyer.
The longer you keep the property financed under the loan with purchased points,
the more the money spent on the points will pay off. If the intention is to buy
and sell the property or refinance in a rapid fashion, buying points is actually
going to end up costing more than just paying the loan at the higher interest
Points may also be purchased to reduce the monthly payment for the purpose of
qualifying for a loan. Loan qualification based on monthly income versus the
monthly loan payment can sometimes only be achieved by reducing the monthly
payment through the purchasing of points to buy down the interest rate, thereby
reducing the monthly loan payment.
Discount points may be different from origination fee or broker fee. Discount
points are always used to buy down the interest rates, while origination fees
sometimes are fees the lender charges for the loan or sometimes just another
name for buying down the interest rate. Origination fee and discount points are
both items listed under lender-charges on the HUD-1 Settlement Statement.
The difference in savings over the life of the loan can make paying points a
benefit to the borrower. If you intend to stay in your home for an extended
period of time, it may be worthwhile to pay additional points in order to obtain
a lower interest rate. Any significant changes in fees should be re-disclosed in
the final good faith estimate (GFE).
Also directly related to points is the concept of the 'no closing cost loan'.
If points are paid to acquire a loan, it is impossible at the same time for a
broker bank or lender to make a premium for a higher rate. When premium is
earned by making the note rate higher, this premium is sometimes used to pay the